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Since his exit from the Obama administration, Larry Summers has parroted the party line that the administration would have loved a larger stimulus but it was just practically i.e., politically infeasible. This line that the administration was united in accepting the need for a larger stimulus was always questionable given Christina Romer’s portrayal of conflicts within the economic team; but now there is more to back up the suspicion that there were opposing views on the size and Larry Summers (as is almost always the case) prevailed with his support of a smaller package. Paul Krugman parses through Ryan Lizza’s report on Summers’s memo to Obama:

The key thing I took away from the memo is that it does not read at all like the current story the administration gives for the inadequate size of the stimulus, which is that they knew it should be larger but had to face political reality.

Instead, the memo argues that a bigger stimulus would be counterproductive in economic terms, because of the â€œmarket reactionâ€. That is, Summers et al were afraid of the invisible bond vigilantes.

And to the extent that there is a political judgment, itâ€™s all in the opposite direction: if the stimulus is too big, weâ€™ll have trouble scaling it back, but if itâ€™s too small, we can always go back to Congress for more.

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And he is level-headed about it, not one of those bleeding heart liberals, this fellow ;-):

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Still, should the Treasury give away money to poor people who dared dream own a house? I am not going to make the â€œpopulistâ€ argument that doing so is better than giving $700 billion to the shareholders and creditors of banks and financial firms over at least 2 years (Iâ€™m sure that the $700 billion would not be the end of the Paulson plan, just like Wolfowitzâ€™s $60 billion budget estimate wasnâ€™t the total cost of the Iraq war). Giving money to people in need, of course, creates horrible moral hazard, which would in turn erode the basis of our civilization. When in distress caused by a disaster not of their creation, people would grow accustomed to receiving the solidarity and support of the rest of society and, thus, would start to behave in self-destructive ways. As we know, only the rich have the moral fortitude to properly use government subsidies: the bigger the subsidies, the more morally they behave. So, no. There would be a quid pro quo, an upside to taxpayers.

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â€œWhat we are working on now is an approach to deal with systemic risks and stresses in our capital markets,â€ said Henry M. Paulson Jr., the Treasury secretary. â€œAnd we talked about a comprehensive approach that would require legislation to deal with the illiquid assets on financial institutionsâ€™ balance sheets,â€ he added.

[…]

The bailout discussions came on a day when the Federal Reserve poured almost $300 billion into global credit markets and barely put a dent in the level of alarm.

Hoping to shore up confidence with a show of financial shock and awe, the Federal Reserve stunned investors before dawn on Thursday by announcing a plan to provide $180 billion to financial markets through lending programs operated by the European Central Bank and the central banks of Canada, Japan, Britain and Switzerland.

But after an initial sense of relief swept markets in Asia and Europe, the fear quickly returned. Tensions remained so high that the Federal Reserve had to inject an extra $100 billion, in two waves of $50 billion each, just to keep the benchmark federal funds rate at the Fedâ€™s target of 2 percent.

But apparently this wasn’t enough for the gamblers in suits:

None of those actions, however, brought much catharsis or relief, with banks around the world remaining too frightened to lend to each other, much less to their customers. This forced Mr. Paulson and Ben S. Bernanke, the Fed chairman, to think the unthinkable: committing taxpayer money to buy hundreds of billions of dollars in distressed assets from struggling institutions.

Rumors about the Bush administrationâ€™s new stance swept through the stock markets Thursday afternoon. By the end of trading, the Dow Jones industrial average shot up 617 points from its low point in midafternoon, the biggest surge in six years, and ended the day with a gain of 410 points or 3.9 percent.

So, how do we characterise this utter failure of private financial entities, requiring the public to step in save the world from their stupidity? Here’s how:

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The owner had been paying a piece rateâ€”a rate per kilogram of fruitâ€”but also needed to ensure that whether pickers spent the day on a bountiful field or a sparse one, their wages didn’t fall below the legal hourly minimum. Farmer Smith tried to adjust the piece rate each day so that it was always adequate but never generous: The more the work force picked, the lower the piece rate. But his workers were outwitting him by keeping an eye on each other, making sure nobody picked too quickly, and thus collectively slowing down and cranking up the piece rate.

Bandiera and her colleagues proposed a different way of adjusting the piece rate: Managers would test-pick the field to see how difficult it was and set the rate accordingly, thus preventing the workers from engaging in a collective go-slow. (If the managers made a mistake in their estimate, and the pickers didn’t earn minimum wage, Farmer Smith would make up the shortfall with an extra payment. This rarely happened.) The economists measured the result. By the time the experiment was over, Farmer Smith’s initial skepticism had long evaporated: The new pay scheme increased productivity (kilograms of fruit per worker per hour) by about 50 percent.

The next summer, the researchers turned their attention to incentives for low-level managers, who would also be temporary immigrant workers but who would be responsible for on-the-spot decisions such as which workers were assigned to which row. The researchers found that managers tended to do their friends favors by assigning them the easiest rows. This made life comfortable for insiders but was unproductive since the most efficient assignment for fruit picking is for the best workers to get the best rows. The researchers responded by linking managers’ pay to the daily harvest. The result was that managers started favoring the best workers rather than their own friends, and productivity rose by another 20 percent.

Small wonder that the economists were invited back for another summer. They proposed a “tournament” scheme in which workers were allowed to sort themselves into teams. Initially, friends tended to group themselves together, but as the economists began to publish league tables and then hand out prizes to the most productive teams, that changed. Again, workers prioritized money over social ties, abandoning groups of friends to ally themselves with the most productive co-workers who would accept them. In practice, that meant that the fastest workers clustered together, and again, productivity soaredâ€”by yet another 20 percent.

The series of experiments provided a fascinating confirmation that financial incentives can trump social networks, with some precision and much detail about the mechanisms involved.

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Scratch even a leftist in the West and you will often find a hippie-hating individualist/reductionist. Every since Dawkins and Sokal, Summers and Pinker did a number on their brethren, many leftists have been labouring (no pun intended) hard to distance themselves from any feel good, “new age”, hippie type framework or explanations. This has to be a bit embarrassing:

Psychologists have long been interested in what happens when people’s internal drives are replaced by external motivations. A host of experiments have shown that when threats and rewards enter the picture, they tend to destroy the inner drives. Paychecks and pink slips might be powerful reasons to get out of bed each day, but they turn out to be surprisingly ineffective — and even counterproductive — in getting people to perform at their best.

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Deci tracked a bunch of college students who were solving puzzles for fun. He divided them into two groups. One group was allowed to keep solving puzzles as before. People in the other were offered a small financial reward for each puzzle they solved.

The psychologist later evaluated the volunteers: He found that people given a financial incentive were now less interested in solving puzzles on their own time. Although these people had earlier been just as eager as those in the other group, offering an external incentive seemed to kill their internal drive.

Rewards and punishments guide the lives of most Americans. Young children are given stars for putting away their toys, kids earn a few bucks for mowing the lawn, and teens are told they will be grounded if they get in trouble. For adults, stock options, raises, demotions and firings become different kinds of carrots and sticks.

Beliefs about the utility of rewards and punishments in motivating human behavior are deeply ingrained, and most people don’t know that more than 100 research studies have shown that motivating people in this manner can have the unintentional effect of undermining their internal drives.

The striking thing about the research, said Roland Benabou, an economist at the Woodrow Wilson School of Public and International Affairs at Princeton University, is that it is so starkly at odds with bedrock economic principles.

“A central tenet of economics is that individuals respond to incentives,” Benabou noted in one research study. “For psychologists and sociologists, in contrast, rewards and punishments are often counterproductive, because they undermine intrinsic motivation.”

But wait, there’s more… the killer part, in fact:

But rewards and punishments are not always counterproductive, Benabou said. He drew a distinction between mundane tasks and those that carry meaning for people. In the first case, Benabou argued, rewards and punishments work exactly the way economists predict: They get people to do things.

External rewards and punishments are counterproductive when it comes to activities that are meaningful — tasks that telegraph something about a person’s intellectual abilities, generosity, courage or values.

Killer part because it spells out what any worker knows to be true — rewards and punishments (more often the latter) are employed to get us to do the dirty work of those handing out the rewards and punishments.

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Paul Krugman has been writing a series of excellent blog posts recently that dare question the techno-optimism crowd that sees any questioning of the unsustainability of human overconsumption as a return to Malthusian thinking (population control, etc) that explicitly or implicitly disfavours the poor. Here is Krugman’s latest post:

You might say that this is my answer to those who cheerfully assert that human ingenuity and technological progress will solve all our problems. For the last 35 years, progress on energy technologies has consistently fallen below expectations.

Iâ€™d actually suggest that this is true not just for energy but for our ability to manipulate the physical world in general: 2001 didnâ€™t look much like 2001, and in general material life has been relatively static. (How do the changes in the way we live between 1958 and 2008 compare with the changes between 1908 and 1958? I think the answer is obvious.)

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I think the fear that responses to human overconsumption (a consequence of human population growth, but not just that — after all the United States with 5% of the world population consumes 20% or more of its resources) target the poor, is a legitimate one. However, techno-utopianism is fast receding as a respectable alternative [attitude] to solving these real problems.

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At the same time, the cost of living and doing business is soaring. The headline inflation rate is hovering near 5 percent, vs. 3.3 percent for the euro zone as a whole. And the euro’s rise against the dollar and the pound sterling has made Ireland much less competitive in its two main export markets. That, in turn, has led many manufacturers, both Irish and foreign, to eliminate local positions. Over the last year, big multinationals such as Pfizer, Procter & Gamble, Motorola, Vodafone, and Allergan have cut scores of Irish jobs. Irish unemployment topped 5.2 percent in February, up from 4.5 percent a year ago.

The upshot, says Jim Power, chief economist at the Dublin-based financial-services group Friends First, is that Ireland’s global competitiveness has markedly deteriorated. That’s a view also shared by the European Central Bank, which recently issued a report showing that for the second year in a row, Ireland suffered the biggest decline in competitiveness of the 15 countries in the euro zone.

Multinationals Pull Back

Now Power and others fear that Ireland’s decline, coupled with increased competition from lower-cost, emerging markets, is threatening the very foreign direct investment that made its economy so successful in the past two decades. The country hosts nearly 1,000 foreign multinational companies that employ more than 150,000 workers. Led by technology giants such as Intel and Microsoft and pharmaceutical firms such as Wyeth and Amgen, these companies were attracted by Ireland’s low, 12.5 percent corporate tax rate, skilled workforce, and business-friendly environment.

There are already signs that the pace of foreign investment is slowing. A recent report from consultancy OCO Global showed that the amount of direct foreign investment into Ireland fell by 5 percent last year, to $2 billion. At the same time, the number of Irish jobs created as a result of foreign direct investment fell by 40 percent. Case in point: Last October, Amgen, the world’s biggest biotech company, announced it was shelving plans to build a billion-dollar manufacturing plant in County Cork.

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Forget all the damage control about this thing being significant but small, with localised effect… a quick tally of the chart at BBC, of losses declared thus far, comes up with about $80 billion. While that’s not in the Bush league of screw-ups (he being the genius who is spending upward of a billion dollars a week to kill Iraqis) but it sure is beginning to look like real money. And that’s not just me… read below on what Herr Wheeldon, one of the moneybag insiders (a.k.a “senior strategist”) has to say.

Citigroup is far from alone in being hit by bad debt, but its write-off is by far the biggest announced by any bank to date.

Analysts generally welcomed the results, as the $18.1bn bad debt write down was less than market expectations of $20bn.

However, analysts had mixed views on what message cutting the dividend and selling securities sent to the market.

“It does nothing to send any signal that we are anyway near the end of the road that we’ve been going along for the past seven months, in the overall credit market woes,” said Howard Wheeldon, senior strategist at BGC partners.